The market was once again rattled by another case of accounting fraud last week - this time at WorldCom -- but in this instance, stocks stood tall. In the process, the major indexes successfully tested their September, 2001, lows, and made a fairly impressive showing. The potential for a fairly decent rally over the next couple of months is better than 50-50. But we still believe a much better time for investors to become aggressive will occur in the third or fourth quarter.
The latest market decline since the Nasdaq topped out in January and the S&P 500 formed a double top in March, has been caused by a complete loss of confidence by investors as accounting problems -- and outright lies and deceit - at some major U.S. corporations come to light. While the economy is not great (though it's not that bad, either), corporate earnings have failed to rebound, and valuations remain a problem in some sectors, it appears investors have tarred all stocks with the same brush, selling companies both good and bad.
The backdrop that has caused many bear markets is rising inflation and soaring interest rates, both very good reasons not to be invested in the stock market. However, it is completely different this time as those two factors are certainly not in play. The selling has been due to concern over certain weak sectors (technology, telecom) and lately, shocking news from individual companies. Unless the entire corporate world has cooked the books, and that this is not just isolated to a relatively few aggressive companies, then we think the latest selling is probably overdone and that the worst is behind us.
The S&P 500 hit an intraday low of 953.08 on Wednesday, June 26, while the Nasdaq printed a low of 1375.53. The closing low for the "500" on Sept. 21, 2001, was 965.80, with a print low of 944.75. During Wednesday's test, the Nasdaq exceeded the Sept. 21 print low of 1387.09 just slightly. While the 950 area for the S&P 500 is very important, as is the 1380 zone for the Nasdaq, those levels can be breached on a retest. For the "500", any test within 2% below the September levels is okay, and for the Nasdaq, 5% under the Sept. 21 lows is acceptable. However, anything more than that would place the test in serious doubt, and suggest that another down leg is upon us.
Although we believe the worst has been seen for the market, there has not been the required accumulation of evidence that would suggest we have entered an intermediate-term advance. This must occur over the next couple of weeks and will be witnessed by strong up/down volume on both the NYSE and the Nasdaq. Until that happens, this is certainly not the time to jump back in with both feet. Remember, new advances must show firm evidence that institutional distribution has been replaced by strong accumulation patterns.
Most successful market bottoms have a number of common characteristics. The first one is some type of reversal formation such as a double bottom or a head-and-shoulders bottom. The current formation is an attempt to trace out a very wide double bottom. The second characteristic of a final low is that prices get very oversold on both a short-term and an intermediate-term basis. This has certainly occurred on both the Nasdaq and the S&P 500, as well as about every other major index.
The third characteristic of a major bottom is a complete washout in market sentiment. This has occurred for the most part. Short-term investment polls (Consensus and MarketVane) have gone to the lowest levels of bullishness since the market low last spring. In fact, the percent of bulls in the Consensus poll has been below 30% for 10 weeks in a row and nine straight weeks for MarketVane. There have been six daily readings of over 1.00 on the CBOE put/calls while there were five in September. Last Friday, the put/call ratio hit 1.27, the highest level since the major bottom in December, 1994. The 30-day exponential moving average hit 0.90, the highest since April, 1995. The NYSE specialist/public short sales ratio (as of 6/7) fell to 0.6, the lowest since September and a very bullish reading.
The one sentiment reading that still needs to get more bearish is the Investor's Intelligence poll, but it has moved in the right direction in the last four weeks. The percentage of bulls is 42.4% and the percent of bears is 36.4%. At market bottoms, many times there are more bears than bulls.
The temptation at this point would be to jump back into the market with both feet. But we are still in a vicious bear market, so it is only appropriate to dip a toe or two right now. Arbeter is chief technical analyst for Standard & Poor's